Market Failure and Government Intervention

Why does the government intervene? The free market is not always able to achieve allocative efficiency. – Market Failure An allocative efficient point is where All resources are allocated to their most efficient use All markets are in equilibrium The economy is operating on its production possibility curve. It is not possible to make someone better off without making someone else worse off (Society’s well being is maximised) This situation is also called Pareto efficiency We will be looking at situations where it is possible to make someone better off without making someone else worse off. This is when governments intervene in the market.

Conditions for the market to achieve allocative efficiency Requires clear price signals There must be Perfect Competition Perfect Information Perfect Mobility Consumer Sovereignty No Externalities or public goods Reading Price Signals

Market Failure Market Failure can occur from any of the following The existence of imperfect market structures Externalities Public Goods Merit and Demerit goods Situations where the market leads to inequitable (unfair) outcomes

Market Failure Markets can fail in a number of ways Some products may be under produced or not produced at all. ie parks Some products may be produced or over produced but are not wanted by society ie drugs The production and consumption of some products affect third parties. ie pollution and smoking cigarettes. The distribution of market income may not enable all citizens to participate meaningfully in society

Market Failure Market failure provides governments with the reason to intervene in the economy or in particular markets that are failing. Government intervention aims to overcome the failure of markets to move towards a more allocatively efficient position

Government Intervention Four functions of the government 1. Legislative/Regulator Role Legal Framework Providing a framework so buyers and sellers know their rights and obligations – enables fair dealing. Legal system used to clarify, define and enforce property rights. Promoting Competition Commerce Commission. Correcting for externalities

Government Intervention 2. Allocative Role Governments allocate resources that the market fails to produce in sufficient quantities 3. Distributive Role Governments aim to promote equity (fairness) This may be done through redistribution of incomes 4. Stabilisation Role Government aims to provide a stable economic environment

Indicate which Government Function is being done when…. cuts taxes to reduce unemployment specifies that a manufacturer is liable for any harm caused by its product places a tax on a steel producer’s pollution legislates that it is illegal to discriminate on the basis of gender, ethnicity or sexual orientation imposes a wage/price freeze provides funding for a job search scheme provides benefits for low income families provides childcare funding to allow women to work legislates to prevent misleading advertising prevents large companies from merging

Range of Government Interventions Method Effect/ what it is Best for: Subsidy Sales Tax Income Tax Regulations Transfer Payments Public Ownership/ Provision Lowering the price to encourage the production and use of certain products. More resources are allocated to a good/service than would be provided by the free market. Lowers the cost of production Raises the price to discourage the production and use of certain products. Pay for some of the costs imposed on society as a result of the product being consumed Increases the cost of production Reduces Incomes Reduces demand. Progressive taxation narrows the gap between rich and poor and reduces inequality of income Limit or prohibit the production or consumption of certain products. Enforce the production or consumption of certain products More direct effect than taxes or subsidies Addressing income inequality in form of social welfare benefits and income support. Redistribution of incomes from “rich to poor” Situations where its not socially desirable for provision to be in private ownership. Providing G&S not sufficiently provided by the free market Army, Police Libraries, parks, Rubbish collection, Education